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With global aerospace and defence (A&D) majors positioning themselves to fulfil expected defence offsets obligations through partnerships with Indian A&D companies, consultancy firm PricewaterhouseCooper (PwC) has released a report that examines the opportunities and pitfalls in this globalising sector.
The defence offset obligation that global A&D corporations must meet in India require foreign vendors who sign contracts worth more than Rs 300 crores for supplying defence equipment to India to source from Indian companies at least 30% of the value of the contract. India's current levels of defence spending could generate offsets worth Rs 15,000 crores annually.
The PwC report starts by establishing that the A&D sector is highly global in terms of sales, but only partially globalised from the viewpoint of supplies. For example, Canadian aerospace major, Bombardier, has customers in over 100 countries; but components and materials are sourced from just 40 countries.
The PwC report stipulates that an industry can be considered to be rapidly globalising when it meets three conditions. Firstly, when a high percentage of the total industry trade consists of import/export. A second qualifier would be established international supply chains based upon offshore production; and, thirdly, when crucial technology/R&D units are spread across the globe.
Judging by these parameters, the A&D industry is not as globalised as the computer, basic chemicals, pharmaceuticals, electronics, instruments, electrical machinery and automotive industries. (see chart)
Another indicator that the A&D industry is international, but not yet global, is the pattern of industry mergers and acquisitions over recent years: In 2009, 76% of all deals valued above US $50 million centred on North America, the UK and the Eurozone.
PwC also found that a mere 12% of more than 250 board members of the world's top ten A&D majors were foreign nationals. Half of the executive boards did not have a single foreign member. In contrast, 27% of board members of pharmaceutical companies were foreign nationals.
Amongst the major issues that impede the globalisation of the A&D industry are: apprehensions about protecting IPR; tight export control limitations; and varying attitudes towards tackling fraud.
The urge to protect IPR remains the greatest hurdle, since expanding into foreign markets demands the transfer of protected technology and manufacturing know-how. The risk grows when the foreign partner has weak IP laws, courts and enforcement.
Countries like India, China and Poland present a Hobson's choice to foreign investors. These three emerging economies, which are the most attractive for aerospace and defence investments, are considered to have below average IPR protection. Second-rung alternatives like Brazil, Turkey and Mexico have even weaker IP protection.
The PwC report recommends that IP transfer risks be accepted when they relate to non-critical technologies. Alternatively, long-established IP, with adequate patent protection, can be transferred offshore. However, R&D functions cannot safely be transferred to markets in which IP laws or enforcement is weak.
Export controls, the other major hurdle before globalisation, consist of tight restrictions worldwide on A&D exports, primarily for national security concerns.
While the need to control defence exports will remain, the PwC report points out that the increasing use of commercial off-the-shelf (COTS) equipment for defence applications also results in commercial A&D products becoming subject to export restrictions. The US International Traffic in Arms Regulations (ITAR), the world's most comprehensive and stringent military export control regime, mandates that if a commercial airliner includes any restricted equipment, the entire airliner can be designated a defence article.
A well-known case is that of the commercial QRS-11 gyroscopic microchip, which became restricted when the US military used it in guided missiles. In 2003, after Airbus and Boeing used the same chip for airliner avionics, those civil aircraft became subject to the same restrictions as military platforms. Boeing was able to deliver an order of 737 airliners to China only after obtaining a last-minute presidential waiver.
Increasingly, companies are seeing ITAR compliance not as a business cost but as a strategic opportunity for creating a competitive advantage. Many European companies believe that demonstrating ITAR compliance is a good way to prise open the lucrative US market.
Finally, the PwC report highlights the varying national responses to fraud. The US has the strongest rules against fraud, notably the Foreign Corrupt Practices Act (FCPA) of 1977. This is also implemented most strongly: since 2005, the US has pursued more cases under the FCPA than during the preceding 28 years.
Other European countries like Norway, Germany and Switzerland enforced anti-corruption measures almost as enthusiastically as the US. But other culturally similar countries like the UK, France, Belgium resembled India and Russia in their less-than-vigorous response to employee fraud.
The defence offset obligation that global A&D corporations must meet in India require foreign vendors who sign contracts worth more than Rs 300 crores for supplying defence equipment to India to source from Indian companies at least 30% of the value of the contract. India's current levels of defence spending could generate offsets worth Rs 15,000 crores annually.
The PwC report starts by establishing that the A&D sector is highly global in terms of sales, but only partially globalised from the viewpoint of supplies. For example, Canadian aerospace major, Bombardier, has customers in over 100 countries; but components and materials are sourced from just 40 countries.
The PwC report stipulates that an industry can be considered to be rapidly globalising when it meets three conditions. Firstly, when a high percentage of the total industry trade consists of import/export. A second qualifier would be established international supply chains based upon offshore production; and, thirdly, when crucial technology/R&D units are spread across the globe.
Judging by these parameters, the A&D industry is not as globalised as the computer, basic chemicals, pharmaceuticals, electronics, instruments, electrical machinery and automotive industries. (see chart)
Another indicator that the A&D industry is international, but not yet global, is the pattern of industry mergers and acquisitions over recent years: In 2009, 76% of all deals valued above US $50 million centred on North America, the UK and the Eurozone.
PwC also found that a mere 12% of more than 250 board members of the world's top ten A&D majors were foreign nationals. Half of the executive boards did not have a single foreign member. In contrast, 27% of board members of pharmaceutical companies were foreign nationals.
Amongst the major issues that impede the globalisation of the A&D industry are: apprehensions about protecting IPR; tight export control limitations; and varying attitudes towards tackling fraud.
The urge to protect IPR remains the greatest hurdle, since expanding into foreign markets demands the transfer of protected technology and manufacturing know-how. The risk grows when the foreign partner has weak IP laws, courts and enforcement.
Countries like India, China and Poland present a Hobson's choice to foreign investors. These three emerging economies, which are the most attractive for aerospace and defence investments, are considered to have below average IPR protection. Second-rung alternatives like Brazil, Turkey and Mexico have even weaker IP protection.
The PwC report recommends that IP transfer risks be accepted when they relate to non-critical technologies. Alternatively, long-established IP, with adequate patent protection, can be transferred offshore. However, R&D functions cannot safely be transferred to markets in which IP laws or enforcement is weak.
Export controls, the other major hurdle before globalisation, consist of tight restrictions worldwide on A&D exports, primarily for national security concerns.
While the need to control defence exports will remain, the PwC report points out that the increasing use of commercial off-the-shelf (COTS) equipment for defence applications also results in commercial A&D products becoming subject to export restrictions. The US International Traffic in Arms Regulations (ITAR), the world's most comprehensive and stringent military export control regime, mandates that if a commercial airliner includes any restricted equipment, the entire airliner can be designated a defence article.
A well-known case is that of the commercial QRS-11 gyroscopic microchip, which became restricted when the US military used it in guided missiles. In 2003, after Airbus and Boeing used the same chip for airliner avionics, those civil aircraft became subject to the same restrictions as military platforms. Boeing was able to deliver an order of 737 airliners to China only after obtaining a last-minute presidential waiver.
Increasingly, companies are seeing ITAR compliance not as a business cost but as a strategic opportunity for creating a competitive advantage. Many European companies believe that demonstrating ITAR compliance is a good way to prise open the lucrative US market.
Finally, the PwC report highlights the varying national responses to fraud. The US has the strongest rules against fraud, notably the Foreign Corrupt Practices Act (FCPA) of 1977. This is also implemented most strongly: since 2005, the US has pursued more cases under the FCPA than during the preceding 28 years.
Other European countries like Norway, Germany and Switzerland enforced anti-corruption measures almost as enthusiastically as the US. But other culturally similar countries like the UK, France, Belgium resembled India and Russia in their less-than-vigorous response to employee fraud.
